Part 20 Technical Analysis – Market profile and market volume

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What is volume profile trading?

One of the most common ways for traders is to make use of the common concepts in technical analysis. These concepts include aspects such as utilizing support and resistance levels, price action based techniques, chart patterns and technical indicator based trading setups.

However, a new approach to technical analysis called volume profile has also been making the rounds.

Steidlmayer, the author of Trading with Market profile has been widely attributed to developing the concepts of volume profile trading.

An established futures trader, Steidlmayer is an independent trader having joined the Chicago Board of Trade in 1963.

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One of the major claims of using volume profile strategy is that is allows you to build the market concept based on the study of volumes printed on the y-axis on the price chart.

Volume as an indicator is not uncommon. It is commonly used during the technical analysis of a stock chart. Volume is also widely prevalent in forex trading as well.

However, for the most part, volume is confined to the x-axis. The volume indicator basically shows the amount of transactions that take place during a session. Based on whether price was bullish or bearish, the volume bars are painted accordingly. This is known as volume profile or market profile.

With volume profile, traders focus on areas where a reversal could occur. Some say that volume profile analysis gives an “unfair” advantage due to the market context and that such methods are used by large institutions and banks.

Be that as it may, volume profile strategy makes for an interesting study as it puts the often taken for granted volume bars in context and allows for some unique insights into the markets when trading.

But before we begin, let’s start from the very basics, what is volume?

What is volume?

Volume, or volume of trade shows the total number or quantity of contracts or shares that are traded for a specific security. Volume can be measured on just about any financial security.

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Most commonly, volume is used in futures and stocks. Due to the fact that futures and stocks are traded at an exchange, one is able to get a fair idea on the quantity of contracts or shares that change hands.

Volume is also used in the forex markets. However, the major drawback here is that due to the OTC nature of forex execution, it is difficult to get a full picture of the true volume for the forex markets.

Still, many brokers offer the volume indicator, plotted as a histogram on the x-axis. This volume, in most cases captures just a small percentage and therefore does not reflect the true picture. Regardless, many forex traders continue to prefer to use the volume indicator.

The first chart below shows the basic layout of a stock chart with the volume bars displayed at the bottom of the chart.

Figure 1: Basic stock chart with volume bars plotted on the x-axis

The volume basically represents the amount of transactions that take place. Volume can also be used to measure the liquidity of the security in question. Generally speaking, volumes are reported once an hour by exchanges. However, these days of electronic trading can report volumes on a tick by tick basis. Still, these volumes that you see in real time are only estimates. The true and actual volume is showed only the next day for the previous day.

When volumes are high, it signals that the security is liquid and active. A security with higher volume also tells you that the order executions and the spreads are better.

What is volume profile strategy?

The volume profile strategy is basically a study of the volume based on price. This is a bit different compared to the regular volume bars that we mentioned in the previous section of the article.

While regular volume tends to display the total volume of the security for a given session, volume profile displays the volume of the security for a given price.

As a result, volume profile is plotted on the y-axis as it deals with price. To explain this in simpler terms, volume profile takes the total volume that is traded at a specific price level during the specified period and then divides the total volume.

This is then categorized into the buy volume or sell volume and makes this information available visually as it is plotted on a histogram on the y-axis.

The next chart below shows a sample chart with the volume profile. For context, we also retain the regular volume bars on the x-axis.

Figure 2: Volume profile example

The longer horizontal volume bars are the ones of interest. These bars represent the price where there is the highest amount of volume. In other words, the price level depicted by the horizontal volume bars indicate the price where most of the activity has taken place.

This price is commonly referred to as the point of control or PoC. The name comes from the fact that the price in question had the most control of the market at the time.

The volume profile bars can be plotted across different time frames. The horizontal volume bars are updated every time there is a new order that is filled. Every time the volume profile bars are updated, they can change the position.

A common occurrence is to see the point of control or the price where most of the activity takes place, starting at the top of the chart as a new trading session begins. Over the course of the day, this point of control can shift thereafter to a different price level.

In market profile or volume profile analysis, there are some technical jargons that are commonly used. They are defined below.

High Volume Nodes: These are price levels that have the highest activity around a price level. The high volume nodes can be viewed as an indicator for consolidation of price.

In the high volume nodes, you can commonly see a high level of both buying and selling activity. Price also remains at this level for a long period of time.

The high volume nodes imply the fair value for the security in question. When price approaches a previously established high volume node, you can expect price to consolidate or move sideways. It is less likely that the market will immediately break past a previous high volume node.

Due to the high amount of activity that takes place at the high volume nodes, price tends to gravitate back to these levels. The high volume nodes are also seen as levels where there is a high amount of institutional buying and selling taking place.

Low Volume Nodes: These are the exact opposite to the high volume nodes. The low volume nodes signify a drop in the volume around a price level. The low volume nodes are created as a result of a breakout in price after consolidation.

During a breakout, you can often observe that price breaks with an initial burst of volume and later it drops off. These drop off levels imply that the price of the security is at an unfair value.

When price approaches a previous low volume node, there is a greater chance that price will break past that level due to the unfair value. The price of the security will not spend must time at this level compared to the high volume nodes.

Point of Control: The point of control is the price level at which there is the highest activity that takes place. Note that time is not of the essence here. Therefore, the point of control takes into account only the price level which has seen the most consolidation.

The point of control, from a trading set up perspective is said to be the level where you could place your stops or entry levels for a trade. Price also tends to revisit the previous point of control levels. This tends to act as both support and resistance.

Value area: The value area is basically the percentage of all the volume that is traded. The default setting for the market profile indicator is 70%. The value of 70% is based on the normal distribution curve.

The next chart below shows all the above technical terms visually.

Figure 3: Market or Volume profile – Terminology

Volume profile trading set ups

So far, we outlined what is volume and how volume profile differs from the traditional volume indicator that is commonly used.

With the volume profile indicator plotted on the price chart and on the y-axis based on the point of control, the high and low volume nodes, you can now get a clear picture of what is happening.

One of the most commonly used volume profile trading set ups is to use the price levels as areas of support and resistance.

We already noted that the high volume nodes are areas of consolidation where most of the transactions take place, but price moves sideways. These areas can be used as support and resistance. Similarly, the low volume nodes which tend to have little activity can also be used as areas where price could either quickly reverse or drop off.

One of the main differences in using volume profile trading set ups is that they are reactive in nature. The common ways to plot support and resistance levels are basically through trend lines and identifying areas of consolidation. Similarly, using volume profile analysis, a trader can build a reactive market context using this strategy.

Volume profile in forex

The next chart below shows some simple examples.

Figure 4: Volume profile trading set up, example 1

In the above chart, you can see that we have used a 20 and 50 period exponential moving average. The dashed black lines indicate areas of low volume nodes.

The red thick line indicates the point of control. If you were to trade the chart based only on the moving averages, you will notice that after the bearish sell signal (on the right), price initially falls to the point of control and bounces back.

However, a little while later, price breaks the point of control. At this point, short positions can be taken after the point of control is cleared with a strong bearish candlestick. With the two EMA’s already signaling a sell, a short position here can be taken down to the low value node.

The most amazing point about this set up is that you entered the trade at the strong point of the trend and booked profits right at the low value node. Following the decline to the low value node area of 1183 – 1175, price bounces back higher.

Figure 5: Volume profile trading set up, example 2

In the next chart above, we simply fast forward the chart but retaining the old values. Here, you can see that after the initial bounce off the low value node area, you can see a new point of control. When we combine the moving averages and the point of control, you can see how price reacts to the point of control.

This is the area where you would be entering the trade to the long side.

With the two period EMA’s already in a bullish signal, the long position from the point of control is take targeting the previous low value node. Notice how price consolidates at this area and the previously formed low value node turns into a high value node?

Booking profits here once again shows how you can enter the trade at the strongest point in the trend.

What we currently see on the charts is that price is near a high value node. Therefore, we could expect to see the price decline and retest the previous high value node around 1292 – 1285 level.

In conclusion, volume profile analysis shows traders the price levels and the amount of volume that was traded during the session. Volume profile is dynamic in nature and changes as the market evolves. At the same time, volume profile also builds the market context.

The trading set ups shown here is just one of the many ways that volume profile can be incorporated into developing a trading plan or strategy. Traders can experiment with the volume profile indicator with the understanding and the explanation provided in this article.

How to Use Volume to Improve Your Trading

Volume is a measure of how much of a given financial asset has traded in a period of time. For stocks, volume is measured in the number of shares traded and, for futures and options, it is based on how many contracts have changed hands. The numbers, and other indicators that use volume data, are often provided with online charts. Looking at volume patterns over time can help get a sense of the strength or conviction behind advances and declines in specific stocks and entire markets.

Basic Guidelines for Using Volume

When analyzing volume, there are usually guidelines used to determine the strength or weakness of a move. As traders, we are more inclined to join strong moves and take no part in moves that show weakness—or we may even watch for an entry in the opposite direction of a weak move. These guidelines do not hold true in all situations, but they offer general guidance for trading decisions.

Key Takeaways

  • Volume measures the number of shares traded in a stock or contracts traded in futures or options.
  • Volume can be an indicator of market strength, as rising markets on increasing volume are typically viewed as strong and healthy.
  • When prices fall on increasing volume, the trend is gathering strength to the downside.
  • When prices reach new highs (or no lows) on decreasing volume, watch out; a reversal might be taking shape.
  • On Balance Volume and Klinger Indicator are examples of charting tools that are based on volume.

Trend Confirmation

A rising market should see rising volume. Buyers require increasing numbers and increasing enthusiasm in order to keep pushing prices higher. Increasing price and decreasing volume might suggest a lack of interest, and this is a warning of a potential reversal. This can be hard to wrap your mind around, but the simple fact is that a price drop (or rise) on little volume is not a strong signal. A price drop (or rise) on large volume is a stronger signal that something in the stock has fundamentally changed.

Exhaustion Moves and Volume

In a rising or falling market, we can see exhaustion moves. These are generally sharp moves in price combined with a sharp increase in volume, which signals the potential end of a trend. Participants who waited and are afraid of missing more of the move pile in at market tops, exhausting the number of buyers.

At a market bottom, falling prices eventually force out large numbers of traders, resulting in volatility and increased volume. We will see a decrease in volume after the spike in these situations, but how volume continues to play out over the next days, weeks, and months can be analyzed using the other volume guidelines.

Bullish Signs

Volume can be useful in identifying bullish signs. For example, imagine volume increases on a price decline and then the price moves higher, followed by a move back lower. If the price on the move back lower doesn’t fall below the previous low, and volume is diminished on the second decline, then this is usually interpreted as a bullish sign.

Volume and Price Reversals

After a long price move higher or lower, if the price begins to range with little price movement and heavy volume, this might indicate that a reversal is underway, and prices will change direction.

Volume and Breakouts vs. False Breakouts

On the initial breakout from a range or other chart pattern, a rise in volume indicates strength in the move. Little change in volume or declining volume on a breakout indicates a lack of interest and a higher probability for a false breakout.

Volume is often viewed as an indicator of liquidity, as stocks or markets with the most volume are the most liquid and considered the best for short-term trading; there are many buyers and sellers ready to trade at various prices.

Volume History

Volume should be looked at relative to recent history. Comparing today to volume 50 years ago might provide irrelevant data. The more recent the data sets, the more relevant they are likely to be.

Volume Indicators

Volume indicators are mathematical formulas that are visually represented in most commonly used charting platforms. Each indicator uses a slightly different formula, and traders should find the indicator that works best for their particular market approach. Indicators are not required, but they can aid in the trading decision process. There are many volume indicators to choose from, and the following provides a sampling of how several of them can be used.

On Balance Volume (OBV): OBV is a simple but effective indicator. Volume is added (starting with an arbitrary number) when the market finishes higher, or volume is subtracted when the market finishes lower. This provides a running total and shows which stocks are being accumulated. It can also show divergences, such as when a price rises, but volume is increasing at a slower rate or even beginning to fall.

Chaikin Money Flow: Rising prices should be accompanied by rising volume, so Chaikin Money Flow focuses on expanding volume when prices finish in the upper or lower portion of their daily range and then provides a value for the corresponding strength. When closing prices are in the upper portion of the day’s range, and volume is expanding, the values will be high; when closing prices are in the lower portion of the range, values will be negative. Chaikin money flow can be used as a short-term indicator because it oscillates, but it is more commonly used for seeing divergence.

Klinger Oscillator: Fluctuation above and below the zero line can be used to aid other trading signals. The Klinger oscillator sums the accumulation (buying) and distribution (selling) volumes for a given time period.

How to Read Volume Profile Structures

The article is authored by Ivan Delgado, Market Insights Commentator at the brokerage Global Prime. This content aims to provide an insightful look into topics of interest for traders such as volume profile analysis. Feel free to follow Ivan on Twitter & Youtube . Make sure you join our discord room if you’d like to interact with Ivan and other like-minded traders. You can also subscribe to the mailing list to receive Ivan’s Daily wrap. Also, find out why Global Prime is the highest-rated broker at Forex Peace Army.

If interested to watch a Youtube video specifically prepared to complement the teachings of this article, you can access the presentation via this link.

As a trader, you are probably accustomed to using concepts such as horizontal lines of support/resistance, trend lines, Fibonacci retracements, round numbers, or other forms of studies to spot reactive areas in your chart, right?

What if you could add the study of volume through the Y-axis of your chart to pinpoint with striking accuracy areas where the price may see a reversal. What if you could also gain an unfair yet real advantage by anticipating the type of market context most suitable to trade with the trend based on the different volume profile structures by the end of the New York close?

In this article, I will unveil an extremely useful tool, widely used by banks and financial institutions, that goes by the name of “volume profile”. Firstly, credit where is due. The father of market profile — from where volume profile evolved from — , is a futures trader named Steidlmayer. Here is a link to his book “ Trading with Market Profile”. Steidlmayer joined the Chicago Board of Trade in 1963, and has been an independent trader ever since.

What Is Volume Profile?

There are two ways of observing the total volume transactions in any market. As a spot forex trader, you can tap into tick volumes as an accurate visual representation of the total traded volume in the X-axis, which would then make your analysis be based on time.

Alternatively, you can carry out your volume study through the vertical Y-axis, in which case, you are analyzing the total activity based on price levels. It is this latter study what volume profile is about; it’s a histogram of the amounts bought and sold at specific price levels as opposed to specific times.

The volume profile allows any trader to evaluate the market context to keep track of the never-ending auction process. That’s what a market is at the end of the day, a constant negotiating process to find equilibrium/agreement (via the accumulation of transactions at a certain level), and the ones that were perceived too cheap or too expensive (no volume found). The art of reading volume profile is all about studying the anatomy of the market auctions.

Before taking things to the next level, allow me to walk you through some basics. When drawing your volume profile in the chart, you must become intimately familiar with the following values:

1. Point of Control (PoC): It refers to the area in the chart with the most traded volume activity. This is by far the most relevant area you want to monitor as it can help to define the placement of your stops or the areas in the chart where you might find the most pristine entry levels. The highest concentrated area of volume for a particular period of time we will call it PoC or Point of Control and you will be surprised how many times it acts as a wall on a retest. Traders tend to factor this in as an area of support or resistance.

2. High Volume Nodes (HVN): Sub-sequences in the chart with high volume activity. While not as powerful nor symbolic as the PoC, the HVN is also a powerful area as it also represents increased trading activity.

3. Value Area (VA): The range of price levels in which a specified percentage of all volume was traded. By default, the industry standards tends to be 70%. Once I explain the principle of the distribution curve below, it will become much clearer why the default number is the 70%, bear with me.

There are three different types of volume profiles to use in your charts. When you first call the volume profile option through the widely popular charting package trading view, the options include:

  • Fixed Range
  • Visible Range
  • Session Volume (Preferred)

I personally find the combination of the daily price action activity and its respective volume flows at specific price levels the most relevant approach as I will demonstrate in the next paragraphs. The session volume allows you to constantly obtain an update to re-evaluate the market, whereas the assessment of the fixed range or the visible range is more discretionary.

That said, the fixed and visible range options also serve as useful tools depending on the purpose of your analysis, that’s why I will also spend some time going through the most valuable benefits of its use.

Fixed Range: Selection Of Interest Levels A La Carte

Trading the markets, especially if you are an intraday trader, involves constant interaction with your charts. You are constantly looking for areas that you can lean against to take certain actions. Right? This first fixed range option allows you to select any area in the chart to deconstruct the total activity. This is a tool that can be of enormous value if you are looking to tighten or trail your stops as well as spotting areas of most interest to enter your positions.

Let’s say that you wanted to play a short in the EUR/USD 30m chart after the breakout of the range. A fairly conventional strategy would have been to wait for the price to break below the two horizontal support levels and enter short on a retest of either one of them. The next logical question would then be, where would you place your stop? If you are trading conservatively, you’d probably be placing your stop somewhere above the 1.16 in order to leave enough wiggle room in case the rebound returns back into the range.

However, if you think about it, there are other areas in the chart that still make a lot of sense to capitalize on. If you were interested in tightening your stop in such a magnitude that your short trade could exploit the prospects of a much larger risk reward, you could then be tapping into the power of the fixed range volume profile to identify at what price level after the range breakout the highest concentration of volume occurred. You could then use this as an area of relevance to assist your action as a seller. In the example, it may have been a great area to play with a much tighter stop.

There is a multitude of examples I could provide about the usefulness of the fixed range volume profile. However, since I want the core of this tutorial to be about the session volume structures, I’d refrain from further chart illustrations unless you want me to (post comments below). I am sure you can figure out how it could be of benefit to you, depending on your trading style.

Visible Range: The Macro View Of The Market

As the name indicates, the visible range option unpacks as much trading activity as data is in your chart. It portrays the big picture view of the most-traded price levels over a specified period of time.

This option is most suited as part of your daily or weekly analysis to spot areas of interest in the chart. By stepping back and projecting an eagle-view from a macro level, it helps you to easily identify key supports and resistances, which is what I mainly suggest to use the visible range for.

One of the most powerful approaches that I recommend is to select your macro areas of interest by zooming out your charts. Once done, you can start drawing horizontal rectangles at every high volume nodes (in black) or low volume node (in red). The areas highlighted will be by far the most relevant that you want to be paying attention going forward.

Session Volume: In Sync w/ The Day-To-Day Context

While the above volume profile options are by themselves very powerful, I refuse to accept that any can beat the ability to be reading the daily auctions.

The auction process in the last 24h of trading provides a roadmap from which to pre-plan your next trading day. If by the end of trading in NY, you are seeking out answers to the questions: What side is in control? Are buyers/sellers accepting higher/lower levels? What side is trapped and therefore has the higher chances of bailing out? All these questions and many more can find an answer via the session volume profile.

Types Of Volume Profile Structures

Single Distribution — Inconclusive Bias

If in the last 24h, the negotiating process ends up with no side in control of the price action, this is represented in the chart by a belly-type curve formation. At the extremes, you can clearly see the tapering of volume, which means an exhaustion of prices amid the lack of sufficient liquidity to find equilibrium. The dynamics of price discovery then suggest that price must revert back to the mean to find new two-way business/acceptance levels.

This structure leads to what’s often referred to as a market in a range. If you think beyond the conventional technical education, the formation of a range is nothing more than the test and failure to agree on higher or lower levels.

The market will constantly be exploring new prices up and down. However, what’s really important is not so much whether or not a level has been tested but the ability by market forces to accept it, thus building value. The thicker the volume on the Y-axis of the histogram, the more value is built as buyers and sellers come to agree on the new area of interest to transact business.

So, let’s tackle the key question. How can we get prepared to trade these structures the following day? Whenever we are presented with a single distribution aka a range, the areas of interest will include the extremes of the range or alternatively, the side in control of the POC (Point of Control).

As the chart below illustrates, the upside edge of the previous day’s single distribution never came even close to be re-rested, but what we did get was a clear rejection off the POC, which then led to a breakout of the range.

In the next example, we have the creation of another single distribution structure. The next day, the price recovers above the POC (red line) and starts to find acceptance with a subsequent backside rejection. That’s a major clue that the resolution of the range-bound conditions might come to a successful conclusion for the interest of the buyers. The moment that in a range the POC starts to act as support or resistance, that’s the first important hint that as a trader you want to pay close attention to gauge the next directional bias.

In the majority of cases, whenever we end up with a single distribution structure, the POC for that day will come nearby the 50 mid-point of the day’s range. This is not a coincidence, as one of the characteristics of the single distribution is its symmetrical structure in line with the principles of the bell or normal distribution curve.

One of the key lessons from the tutorial about the 4 Pillars in Forex included the relevance of the bell curve, which happens to be one of the backbones’s behind statistics and probability theory. It is also essential to understand for you as a trader if you are going to dig deeper into the study of volume profiles.

Remember that one of the natural laws of statistics is that as we increase the repetitious trials of random events that arise from flipping a coin, it results on a more pronounced skewness of results towards the center of the chart or bell shape. This is known as the central limit theorem. This is precisely what’s at play when we see the single distribution structure in volume profile. We have more and more order activity coming through the books with the pre-condition of not creating enough of an imbalance is supply or demand.

As the volume keeps increasing by N = number of times a new order comes in (times someone — human or algos— take a trade), the more pronounced the shape becomes, with the creation of another universal truth in statistics, that is, standard deviations. This states that over 68% of the volume will be accumulated under 1 standard deviation (in blue), while 95% of the volume will come within 2 standard deviations (in red). Now you will understand why the standard market value of a volume profile tends to be 70%.

Multiple Volume Distributions — Directional Flows

It refers to an auction process that creates two or more areas of value via a noticeable volume accumulation in the histogram. In the majority of cases, we will have the creation two distributions, less so a triple distribution structure. In the illustration below, you can find an example of a double distribution day.

As part of the double distribution structures, there are up to 4 subcategories we can classify. Each one of these structures suggests the likelihood of a distinctive price pattern to be expected the next day.

The critical factors that we must account for when evaluating multiple distribution structures include the number of thick areas in the histogram (value built) and the price close. There is a strong dependence on where the price closes by the end of the NY session to evaluate the next day’s play.

Let’s now break down these structures.

Short L-Shape (No Trapped Longs)

Following up with the example of the EUR/USD, in the following 24h, the pricing of the pair created a double distribution structure. As part of this formation, we now need to classify what type of structure it is based on where most of the volume was traded, as depicted by the POC (Point of Control).

On Oct 24, the price spent only a brief period of time before selling-off, leading to a price sequence of low-volume bars through the histogram. As the dust settled, buyers and sellers started to agree on the next level of equilibrium near the lows of the day around the 1.14 area.

This market dynamics are one of the most powerful for an ultimate trend continuation. If we were to decipher the clues behind the auction process, via volume profile, it clearly indicates that the market agrees on the value lower.

The fact that the majority of the volume was accumulated near the lows, and most importantly, with the price closing around the lows of the day near the POC, is a strong statement that the market is not interested in profit-taking.

Therefore, any potential rebound would most likely see sellers committed to adding to their short positions. This is a pattern that runs the risk of resulting in shallow rebounds before the continuation of the trend.

I will also illustrate below what a triple distribution looks like. Here it goes.

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